Sunday, December 6, 2015

Financial advisors, fund
managers, research analysts and other elites of the investing community always
claim that ‘equities provide the highest return among all asset classes in the
long run’. The pink press regularly dishes out data comparing long term returns
from various assets classes, such as equities, gold, real estate, bank deposits
and so on. Usually, stock
market indices such as the BSE Sensex or NSE Nifty are used as proxies for
returns from equities. Stories of successful “long term” investors such as
Warren Buffet, serve as useful mascot to support these claims. The consensus
currently, in the personal finance community, is that to create serious wealth,
you need to invest in equities, and stay invested for the long term.

Rakesh Jhunjhunwala

Rakesh Jhunjhunwala is among India’s best known investors and needs no introduction to the investor community. Recently, I came across a study
published by financial newspaper 'Mint'. The study analyzes 91 stock market investments of
Mr. Jhunjhunwala in 84 companies (some companies were bought & sold more
than once, hence the difference) over the last 10 years where he has held more
than 1% stake at any point of time. Under extant regulations, investments above
1% of a company’s share capital are required to be disclosed to the stock
exchanges, hence this is publicly available data. Before we proceed, I urge you to read the full
Mint article here.

The study finds that Mr.
Jhunjhunwala’s “…average returns have been highest from stocks he held the longest”.
The message for the lay investor, is that the longer you remain invested in a stock, higher your return. This argument is supported by a
quote in the article, attributed to a professor from IIM, Kozhikode, “In the long run,
stock markets in general have been seen to move in an upward direction. Therefore, the longer you hold on, the
probability of superior returns is quite high” (emphasis mine).

However, thisconclusionis not even half the story.

Behind every successful 'long term' investment are nine other not so long term investments

In fact, the Mint study finds that average holding period of Mr. Jhunjhunwala for these investments is just 3.44 years. In 26 out of the
91 investments (i.e. 29% of the time), Mr. Jhunjhunwala has exited the
investment in less than one year. The article itself quotes a study of Warren
Buffet’s investments, which found that “he held most of his stocks for
approximately a year. He held his stake in only a fifth of his companies for at
least two years.” Clearly, Buffet’s favorite holding period may be forever, but only
20% of his investments enter even the third year. This is quite at variance
with the conventional image of these “long term” investors, who are thought to hold their investments for decades, not just years.

Even the market indices
such as Sensex or Nifty that are used as proxy for the equity asset class are not
static. Their composition changes frequently as some stocks are removed and
others added. An article in The Hindu points out (click here) that between the period
2002 to 2012, the Sensex delivered a compounded annual return of 17%. Very
attractive by all means, but during this period the index was reshuffled 18
times, with 26 of the 30 stocks replaced! I am sure if returns were calculated using the same stocks which existed at the start
of the period, they would certainly not turn out to be as attractive.

Conclusion

The Mint article makes a
reference to some of Mr. Jhunjhunwala’s best known investments (such as Titan,
Lupin etc.) which he has held for decades. However, to state that these
investments have provided best returns because
they have been held the longest is to put the cart before the horse. The truth
in fact, is the other way round.

These investments have been held the longest because they have provided
the best returns.

The strategy of ruthlessly
exiting mediocre investments quickly seems as much an integral part of Mr.
Jhunjhunwala’s (or Warren Buffet’s) success as holding on to best for 10 years
or longer. And the ability to differentiate between what to exit and what to
hold on is what makes these investors stand apart from the rest. Not an easy act to follow.